When I realized I might be owing taxes this year instead of getting a refund, I panicked. I wished I could have a do-over when it came to how I handled my retirement savings for the most recent tax year. Fortunately, there are some last-minute strategies for reducing a possible tax bill. One of the main ways I saved myself from a major tax hit was by undoing a conversion with a Roth IRA Recharacterization. According to a recent MarketWatch article, the rich love the Roth IRA. It is a lot easier for the rich to be able to afford the Roth, which requires taxes be paid upfront rather than in retirement. I was overly ambitious in thinking I could afford to convert my former pension into a Roth IRA instead of rolling it into a regular IRA. When it came time to pay the tax man, I was just glad the IRS gives people such as me the chance to have a change of heart.
Pushing into the higher tax bracket
Since the IRS treats a conversion from a regular IRA or similar pension fund to a Roth as income, my move pushed us into a higher tax bracket. If I was wealthy, I could use cash from a savings account to pay the taxes. According to MarketWatch, people in American in 2010 converted $64.8 billion of their retirement funds from traditional IRAs to Roth IRAs. It marked an increase of more than 800 percent compared to the 6.8 billion converted the prior year thanks to a tax policy change that made it easier for higher wage earners. Experts speculate the rich think their income tax rate will be higher when they retire. Since I'm not rich, I can't worry about my income tax rate when I'm older because I have to worry about what I can afford to pay in taxes today.
Filling out the paperwork
In order to recharacterize my Roth IRA, I had to fill out an IRA Recharacterization Request provided by my discount brokerage firm. I had to identify the date of the conversion as well as the amount of the conversion I wanted to apply to the most recent tax year. I could choose to either calculate the Net Income Attributable (NIA) or allow my brokerage firm to calculate the NIA. When filing my taxes, I then had to explain the earnings or losses. Since I had losses in my Roth IRA after the conversion, I will come out ahead by not owing taxes on something that went down in value. I chose to let the experts at my brokerage firm figure out my NIA since the Roth account included the conversion as well as my own personal contributions through the years.
Learning from my mistakes
In the future, I may consider converting money from a regular IRA to a Roth. However, I will make sure I open a separate account so that it's not as complicated to figure out the gains and losses on that one conversion. Also, I will be less optimistic and ambitious about how much I can afford to convert. Unless I have a lot of tax credits in a particular tax year, I may want to hold back on the conversions. Unless my income dramatically increases, I may just leave the money that is already in a regular IRA account and just slowly add to my Roth IRA account.
I thought about other last-minute ways I could lower my taxable income, but nothing was as effective for me as the Roth IRA recharacterization. I could have scrambled to contribute to a regular IRA for last year's tax year up until the April 15 deadline. However, I didn't have the extra money to spare. Instead of getting too depressed about the fact that I won't have as much money in my Roth, I focus on how I can do better next time around.
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